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Morons Increase Margin
An interesting thing happened to my experimental account lately. You remember -- the one I blow up every few months or so. Over the past few months that account has not just survived, but has actually thrived performing better than even some of my “real” money accounts.
Last week I wrote that the one key change I made to my trading was to never, ever, ever, ever, ever, ever, ever, ever add to a losing position. That’s certainly been the key to my success over the past few months. But I also implemented another change that may have just as valuable.
For the past 3 months I have set my default trade size at only 2 times leverage. In other words for every $10,000 in the account I trade only $20,000 of notional currency in any one trade. That may seem laughably small to those of you who regularly trade with 20:1 or 50:1 lever factor, but trust me -- it has made all the difference.
Trading small has allowed me to recoup from drawdowns with ease since no single trade clips me for more than 1% of my account. Furthermore what most traders fail to understand is that the leverage in your account is determined not by any one position but by the aggregate amount of trades outstanding. Suppose I am long EUR/USD, GBP/USD and AUD/USD at 2:1 lever factor on each. For all intents and purposes that is simply one big anti-dollar trade at 6 times leverage. Now if your default trade size is set at 10:1 leverage you would in effect be levered 30:1 in your account at that particular time! And novice traders wonder how is it that they lose money so fast!
Amazingly enough low leverage has not hurt my performance one bit. I am up 8% since the start of this year and I am up about 37% since my last orgy of averaging down in mid October. Trading small has not stopped me from making money because I trade frequently, and as I’ve explained in the past, you can get the benefits of leverage two ways -- you can borrow a lot or you can turn over your inventory several times per day. The former will almost always send you to the poorhouse in the end. The later is how you grow your account with minimal risk.
So next time you are looking make money by increasing your margin, just remember the title of this column.